Wednesday, September 14, 2011

Strategic Planning Analogy #412: It’s Rational To Me

There’s an old story about a champion swimmer who lost one of his little pinky fingers in an accident. After the accident, the swimmer said that he was unable to swim anymore and refused to get back into the water.

His fans thought he was acting crazy. Okay, maybe his swimming might be a tiny bit slower without that finger. But to claim that he couldn’t swim any more at all? This didn’t make any sense to them.

Finally, one of the fans asked the swimmer why he couldn’t swim any more. The swimmer responded, “I use my pinky finger to get the pool water out of my ear after I swim. Without the pinky finger, I can’t get the water out, so I can’t swim anymore.”

To an outsider, a lot of actions look irrational. The fans in the story thought that the swimmer was acting irrational. They didn’t understand how losing a finger prevented the act of swimming.

The problem was that the fans didn’t see the big picture. They were only looking at what happens in the pool. In the pool, the finger loss was not such a big deal.

The swimmer, however, saw the bigger picture. He knew that after he was out of the pool, that finger was essential to maintaining ear health. Without that finger, his ear would get infected and he would not be able to swim in the future.

So, even though the fans thought his refusal to swim was irrational (because they only looked in the pool), the swimmer felt he was being very rational, because he saw the larger implications.

It seems that a similar problem frequently occurs in business. Executives are constantly making decisions. Many times outsiders will look at these decisions and question the rationality of the decision. They will think the executive was crazy or misguided.

Literature in recent years has referred to this supposed irrationality as “decision bias.” The argument for decision bias goes something like this:

1) The decision maker has biases;
2) The biases in the mind of the decision maker triumph over logic;
3) Therefore, the decision maker makes an illogical decision.

However, I’m not so sure this is always the case. Executives don’t make it to the top because of a propensity for illogic. I think there is often something else going on. The ones claiming this so-called illogic are like the swimmer fans. Their view of the decision is too narrow (just looking in the pool). The executive may be looking at a larger scope (outside the pool) and see a reason why his decision is very logical (at least from their larger perspective). So before making a quick judgment about someone’s rationality (or supposed lack thereof), try to understand the perspective of the one making the decision.

The principle here is that if you want someone to make the right strategic decision, then you have frame the decision within the context of the framework used by the decision maker. In other words, don’t blame bad decisions on irrational biases. Blame bad decisions on having created a system where the decision maker’s logic is contrary to the success of the strategy.

This is an important distinction. For if you believe the problem lies with illogical beings, you will try to fix the problem by trying to change the way people think. However, if you believe that the person is very rational, but has been put into a system where his/her personal logic is contrary to business goals, then you will try to change the system.

The Pool Example
Think of the business executives as being like that swimmer and the business environment as being like that swimming pool. As an investor in that business, you focus on what is happening in that pool and how well the swimmer is performing in that pool. You don’t care about what happens outside the pool.

The swimmer (the executive), however, has a life outside the work environment (the stuff outside the pool). In the story, this caused him/her to stop swimming.

The investor thinks this is illogical, since they see nothing in the pool to cause concerns. The investor sees the solution as trying to change the way the swimmer thinks about swimming (try to replace the so-called swimming illogic with logic). Since all the investor looks at is the pool, they try to find the solution within the pool (the way the person performs relative to the business). For example, they might focus on telling the swimmer that, logically, the hand stroke in the water still works with a missing finger (and to think otherwise is crazy).

However, had the investor assumed that the swimmer had a logical reason for his/her actions, the investor would have looked outside the pool at the swimmer’s concern for getting water out of the ear. They would have then come up with a replacement for the pinky to get the water out of the ear. With such a replacement, the swimmer would gladly get back into the pool and do what the investor wants. In other words, the best way to fix what was happening in the pool was to take care of a systemic issue outside of the pool. No amount of lecturing on the best way to swim would have fixed that issue.

The Real Example
I was reminded of this concept in a recent article from September 2011 in the McKinsey Quarterly. The article was entitled “A Bias Against Investment?”. The article was based on a recent survey of executives. According to the survey, executives claimed that their companies were not investing enough in their businesses. And the folks at McKinsey felt that underinvesting at this time was illogical.

McKinsey blamed the illogic on “well-known biases.” As “proof” of these biases, they pointed to some hypothetical questions in the survey. One hypothetical scenario was about a doing a deal with the potential of a small loss or huge reward. Many of the executives refused to do the deal. McKinsey claimed that this was mathematically illogical, in what they referred to as the “loss aversion bias”. McKinsey thought this illogical bias was even more tragic when applied to smaller investments (which were also looked at in the survey and had similar results). To quote the article, “Even if it made sense to be so loss averse for larger deals, it still wouldn’t make sense to be as averse to loss for smaller ones.”

But I think there may be a lot more going on here. There may be some sense here after all. I think those executives may be very logical. They are just using logic from outside the pool. These executives are not only worried about the health of the business, but the health of their career (like the swimmer who cared about the health of his ear).

The executive may have logical reasons to believe that being seen as responsible for losses, even small ones, could put their career at serious risk. They may get fired, not get a bonus, or never see a promotion because of that loss. However, if the upside occurs, the amount of the profits on a small deal may not be large enough to cause any personal benefits to the executive. They were already expected to do well, so doing well does not trigger extra bonuses or promotions.

Given that logic, the executive doesn’t just see what’s in the “pool”—big profit gains versus the risk of a small loss. Instead they see it as gaining nothing personally versus potentially losing their job. No wonder executives have a tendency to be averse to these types of options. From outside the pool, rejection of the deal looks very logical.

The Implications
Depending on which of us is correct (me or McKinsey) there is a major difference as to how to solve the problem. McKinsey’s approach would lead to the conclusion that companies should focus on getting people to change the way they think—to root out those nasty biases—or at least downplay them during decision making.

My approach would be to understand what is happening outside the decision at hand (outside the pool) which is causing a logical person to “rightly” (for them) make the “wrong” choice for the business (inside the pool). Once that is determined, then change the system so that the two are compatible. For example, in the scenario above, the company may need to change compensation and rewards/punishment policies which cause people to act contrary to what is in the best interests of the company. The companies need to get personal risks to be consistent with business risks.

Although luck may be a contributing factor, I believe most people make it to the top of a business because they logically made the right choices regarding what it takes to get to (and stay at) the top. The real problem is that the logical choice for getting to or staying at the top is not always consistent with the most logical choice for the business. If you want to fix some of the bad decisions, look at how to get the logic behind personal and business decisions to be more similar.

Don’t automatically assume that bad decisions are caused by illogical executives. Instead, start by assuming that the executive is being perfectly logical from their perspective. Then try to figure out why the current system is causing personal logic to be out of sync with business logic and fix the system. Otherwise, your “logical” strategy may not get implemented, because it conflicts with the personal logic of the people implementing it.

A personal benefit from looking for a solution by changing the system is that it keeps you from having to go to senior executives and tell them to their face that they are illogical.

1 comment:

  1. I loved your post. I didn't know that people could make reading about strategic planning fun. But you nailed it! I love your analogy. Thanks for the entertainment and very useful information. I will definitely be following your blog.